Chinese shadow banking concerns expand

• Iron ore expected to fall $20 per ton by 2018

• Japan updated indicators show Abenomics succeeding

The impact of bad debts in China’s shadow banking system is likely more important to the global economy than Fed policy, latest research from Nikko Asset Management (Nikko AM), a related entity of Tyndall Investment Management Limited (Tyndall AM) shows.

Unfortunately, due to a lack of transparency and the extremely complicated system, even well-informed global investors cannot grasp the true nature of China’s financial difficulties. Several property trusts have already defaulted, but with rising land prices and generous credit, these have managed to be “worked out;” Recent defaults in the mining and industrial sectors with questionable collateral will likely have more serious repercussions, however.

“Local governments have less capacity to offer rescues considering their own funding issues, and so we expect that many more defaults are likely this year,” said John F. Vail, Chief Global Strategist at Nikko AM’s Tokyo head office. “Meanwhile, other efforts to increase regulation of the shadow banking sector are bound to reduce liquidity, especially to troubled borrowers, and this has some possibility of accelerating into a more serious credit crunch. Thus, we have long been cautious on Chinese equities and despite low valuations, we continue to believe that corporate profit margins will be under pressure and that bank earnings understate the true problem of bad debts.”

In other findings, iron ore is expected to fall in price from its current price level of around $130 per ton towards $110-$120 per ton by 2018, as a result of increased supply from Australia and Brazil. As a key component in steel products, demand for iron ore has surged as a result of China’s ongoing urbanisation process. The inability of iron ore producers to increase supply incrementally has led to a quadrupling of the iron ore price over the past 10 years.

“Looking forward to 2018, assuming the forecasted supply comes to the market, this should have the impact of reducing the iron ore price by around $20 per ton,” said James Eginton, a research analyst at

Nikko AM’s subsidiary, Tyndall AM in Australia. “Thus, the outlook for steel makers has begun to brighten with the potential for margin expansion and improved financial performance over the longer term.”

In Japan, inflation is moving strongly upward, with pipeline inflation rising 0.8% month-on-month in December (3.3% year-on-year). There are also strong signs that this is flowing through to retail prices, with the goods portion of the Consumer Price Index rising 0.7% month-on-month in November and up 5.4% on a 6-month annualised basis.

In an update to our previous report on the Abenomics Wealth Effect, the latest data from the Bank of Japan shows that ¥84 trillion ($805 billion) of household financial new worth (excluding real estate) was created in the 12 months to September 2013, summing to ¥1.24 quadrillion of net financial assets, a record high. The impact of more wealth on consumption will be key to the success of Abenomics.